Jalan Protects NSE

December 2, 2010

The Bimal Jalan committee has delivered a report whose sole beneficiary is the National Stock Exchange

The Bimal Jalan Committee was appointed in February 2010 to deliberate on governance, ownership, listing of bourses and other issues. The result seems to be a ‘special purpose report’ (SPR) that appears to be aimed at helping the National Stock Exchange (NSE) retain its monopoly for the next five years at least and also work at permanently eliminating any competition. Its only rival, the Bombay Stock Exchange (BSE), will soon be starved of funding and become inconsequential while the report’s recommendations will ensure that MCX Stock Exchange (MCX-SX) is not allowed to enter the equity space.While paying some lip-service to the propensity of entrenched bourses to use anti-competition strategies against potential rivals, its solution is to eliminate competition altogether and perpetuate existing monopolies. It also disfavours listing of exchanges which further puts paid to all the plans and ambitions of BSE and MCX.

This is probably the first committee that is so overwhelmingly packed with regulatory officials and just two regulated entities. The result is a set of recommendations that is devoid of any vision to develop or deepen the capital market. Here are some of the bizarre recommendations.

The Jalan committee says banks and financial institutions with Rs1,000-crore+ of net worth can qualify as anchor investors and hold up to 24% (as against 15% today) for a maximum period of 10 years. The objective of the committee is clear. Keep private corporate entities (read MCX-Financial Technologies group) out of the capital market space. But did the committee spend a few minutes debating who these investors would be?

Why would any institution invest 24% in a bourse to get a fixed return, unless directed by the government? Wouldn’t it have been simpler for the committee to recommend nationalisation of bourses with a single monopoly exchange? This would be in line with the committee’s other view—that exchanges are natural monopolies. So, the BSE, once it is nearly dead can be quietly merged into the NSE (in fact, this is already being discussed in certain quarters). Probably the only reason why the Jalan committee has not suggested nationalisation is that institutional directors on the NSE may also suggest that managing director (MD) Ravi Narain, deputy MD Chitra Ramakrishna, and the company secretary, who take home gross salaries of Rs6.7 crore, Rs4.5 crore and Rs2 crore, respectively, would have their salaries brought on par with chairmen of banks or public sector companies.

Instead, the committee slips in a recommendation that sneakily protects the salaries of NSE’s top brass but not those of the BSE. It recommends “No variable pay or stock options” for the top bosses of stock exchanges (SEs). This hits at the top brass of the BSE which is struggling to survive.

Ironically, the committee also suggests a 51% cap on aggregate anchor investor holding. The committee says there must be a cap on profits of stock exchanges and this must be linked to yields on 10-year government bonds after taking into consideration risks faced by market infrastructure institutions (MIIs) including equity risk premium and liquidity risk due to non listing of MIIs. This recommendation, if accepted, should cause investors, especially those who have acquired NSE’s equity expensively, to scramble for the exit door. Surely, Wipro’s Azim Premji (13.5 lakh shares), Rahul & Shrenik Baldota (2.25 lakh shares), S Gopalakrishnan of Infosys (1.71 lakh shares) did not invest in a ‘fixed-income instrument’ of the NSE. Each of them has paid a hefty premium. If the NSE and the BSE were listed entities, their stock would have probably hit the lower circuit after the release of the Jalan committee report. The only reason private investors would stay on is if NSE convinces them that ‘risk premium’ is just a euphemism to ensure there is no real cap on profits or dividends, once NSE is a monopoly.

On the other hand, BSE members, who agreed to demutualisation of bourses (and conversion of their membership rights to equity) in the hope that their holdings would soar on listing, would be badly hurt. The Exchange seems sure to sink and there is little chance it will be able to run a business with returns slightly higher than those from fixed-income securities. Considering that nobody other than NSE’s well-paid and well-entrenched top management is opposed to listing, the committee’s recommendation seems wholly influenced by the monopoly exchange. |The Jalan committee’s recommendations stem from the ridiculous notion that neither stockbrokers nor management can be trusted to construct robust Chinese walls that prevent them from accessing and misusing surveillance-related information or trading positions. It says, no trading and clearing member “should be allowed to be on the board” of any stock exchange. Independent directors on the board, “shall at least be equal to the number of shareholder directors without trading or clearing interest.” The chairman of SEs should be approved by the Securities and Exchange Board of India (SEBI) and not paid any commission or remuneration. Trading members will be relegated to advisory boards to use their “rich practical experience.” SEBI has already started packing boards with retired IAS officers and this trend will only accelerate after the Jalan-Krishnan-Bhave (all former bureaucrats) recommendations are accepted. SEs cannot hold more than a 24% stake in depositories because they have now become independent and self-sufficient entities. The ostensible reason is that management of an exchange may misuse its majority holding to get surveillance-related information. If accepted, this recommendation will force the BSE to reduce its recently increased stake in Central Depository Services Ltd (CDSL) from 54% to 24%. This will again affect BSE’s valuation. This would have upset BSE’s top management, since their variable pay depends on the SE’s performance. With turnover dwindling everyday, the BSE brass could justify bigger bonuses only by showing higher valuations. If the Jalan committee’s recommendation on capping variable pay is also accepted, this becomes a non-issue.

The recommendations reveal how committees packed with yes-men come up with ideas that destroy rather than develop markets. The committee mentions deliberations with several entities and individuals. Many of them say that their views find no mention in the report. While they are hugely agitated, few have bothered to respond publicly, because they hope that the committee and its findings will die a natural death, once there is a new chairman at SEBI. Funnily, the committee itself gives its recommendations only a five-year shelf life. — Sucheta Dalal